Wednesday, January 20, 2010

Dollar Disaster Looms

The dollar is the weakest it has been in over a year. The Euro has recently traded at $1.49 versus $1.26 seven months ago, and twelve months ago $10,000 bought 24,000 Brazilian Reals; now it will only buy 17,000.

Because exports are up, due to the relatively cheap cost of our goods being purchased from abroad, some consider the weak dollar a positive. In addition, there has been some job creation in export companies due to increased demand, although not enough to put a dent in the 10% unemployment rate. However, the continuing erosion of our currency has dark consequences that far outweigh the benefits described above.

A commodities bubble is developing - we see Gold soaring to record highs as investors flee the dollar to put their capital into a stable alternative investment. More significantly and closer to personal consumption, oil prices have been steadily increasing, because, simply put, it costs more dollars to purchase the imported oil we need to sustain the economy. Recently, oil traded around the $80 mark. If we allow the dollar to continue on its current trend, could $100/barrel or more be far behind? This could result in the return of the $4.00 gallon at the pumps. We would go back to the environment we had in the recent past, adversely affecting the consumer budget, which accounts for 70% of our economy. A domino effect would develop – less consumer spending for goods, and higher corporate energy costs would spell lower profit margins, decreased demand and more job layoffs. In addition, any chance for a recovery would be derailed.

Another problem is that the Fed has us at 0%. Why would anyone want to invest money here when they could borrow dollars for practically nothing, and invest them in Asia or other geographical locations? Brazil for example, offers CDs at 8 ¾%, even though recently, wising up, they imposed a 2 % penalty on foreign investors depositing funds into these accounts. Even so, it is still an attractive place to park U. S currency, compared to the little banks offer. Do not forget that elderly savers, who rely on interest earned for support, are also being damaged by the near zero interest rates in our banks.

If we continue on the current path, risk of double digit inflation will become stronger as prices rise. This combined with our increasing debt, printing of too many dollars and foreign investors purchasing and controlling our real estate and other assets; we will become a second rate nation, with a lower standard of living. The treasury should support our currency by raising interest rates to attract capital; if only slightly to 1 or 2 %, it would have an impact by showing that we are confident about the economy’s strength. It should also end the purchase of Mortgage Backed Securities and start buying U.S. dollars.

C. Cohn

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